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Save Money by Understanding “Rates” and “Points”

The percentage of Americans owning homes—66%—is near its highest level in over 15 years (according to the U.S. Census Bureau, 4th quarter, 2011). One reason for this high percentage is that homebuyers are more knowledgeable about the home buying process, thoroughly researching products, services and pricing before they buy.

Many homebuyers are still puzzled by the terms “points” and “rates,” and it’s especially confusing and frustrating when buyers hear the terms intermixed.

The “rate” refers to the actual interest rate a homebuyer pays on a loan. Interest rates vary on a daily—and often hourly—basis, and are determined by multiple financial indicators. Most homebuyers prefer a lower rate, which means a lower monthly payment. However, there are often trade-offs with a lower interest rate, including additional up-front costs and/or a higher loan amount.

“Points,” on the other hand, are lender fees that are usually paid at the time of closing. A point is equal to 1% of the total loan amount. So, if the loan amount were $150,000, one point would be $1,500.

Points and interest rates are inversely related. In general, the more points homebuyers pay, the lower the interest rate they will get. However, the more points they pay, the more cash they will need up front.

Determining whether or not to pay additional points on a mortgage should be based on several factors, including the amount of time a homebuyer intends to stay in the home, the length of time before a homeowner refinances, and how much cash is available to cover closing costs and additional points. Taxes should also be considered, since points and interest are usually tax deductible (consult your tax advisor).

A general rule of thumb is: the fewer years you plan to stay in your home or refinance, the fewer points you should pay. There may be a clear advantage in paying additional points up-front, but talk with your loan officer about all the options to make sure you’re making the right decision for your situation.

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